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Sorting out the messy economics for a fair climate transition

The region’s multilateral development banks and state investment funds appear to be in flux about how money is raised and funnelled towards the energy transition with carbon pricing splitting views.

Carbon Capture_Climate Finance
At the Bloomberg New Economy Forum 2021, representatives from financial institutions said that putting a price on carbon will act as a lever for solutions that are currently not commercially viable, such as carbon capture, to be financed. Image: International Energy Agency

In Asia, many lenders and state investors have yet to reveal strategies on how they will mobilise capital for green projects while accelerating the push on carbon-intensive sectors, that are sitting on their books, to pivot to low-carbon business models.

Speaking at the Bloomberg New Economy Forum in Singapore last week, representatives from regional financial insitutions appear to have rallied around the idea of a carbon pricing strategy but are treading carefully around how to price the planet-warming pollutant. 

There was also a lack of consensus on key financing principles for emerging technology currently not commercially-viable, but has bright prospects as a means to mitigate global climate change. 

The Asian Infrastructure Investment Bank (AIIB) pushed back on the role of multilaterals in the research and development (R&D) of new technologies. Jin Liqun, president of the Beijing-based multilateral development bank, noted that there is still “huge room for efficiency gains” in the realm of solar and wind, but called on regulators and governments to take up bigger responsibilities and use the receipts from carbon taxes for investment in more R&D. 

The AIIB in its research estimates that US$50 trillion is needed by 2050 to help the world achieve its target of a 1.5 degrees Celsius warming goal, said Jin.

“We should not be repeating low-efficiency projects forever,” he said. “The development banks know that, but our hands are tied and we cannot be the ones to invest in R&D. We are not venture capitalists and we can only invest in projects with proven technology.” 

The price on carbon as a lever for technological change

While some experts continue to caution against an over-reliance on market mechanisms to slow climate change, that has not stopped governments from hailing carbon pricing as the single most important way to reducing emissions. 

Whether through a carbon tax, where a fixed price is paid per tonne of greenhouse gas, or a cap-and-trade programme – which puts a limit on sectors’ and firms’ emissions – the mantra is the same: putting a price on carbon will provide the vital nudge towards lower-carbon alternatives.

Financial representatives speaking at the forum threw their support behind putting a price on carbon which, they said, will act as a lever that can direct capital efficiently towards carbon-mitigating technologies.

A higher carbon price is likely to trigger companies to slash emissions and will become crucial for investment decisions as markets develop. The European Union’s carbon prices jumped above a record 71 euros (US$79.79) a tonne on 22 November, double the price at the beginning of the year. China’s carbon price has been steady at US$7.88-$8.76/mt but is considered too low to drive significant decarbonisation of the power sector, or incentivise a switch away from coal.  

Temasek Holdings chief executive Dilhan Pillay Sandrasegara, who took over the US$282 billion Singapore state-investment company last month, agreed that pricing carbon competitively is a priority. 

This would help corporations find out the “true cost of capital” of their business models, he said. “The price of carbon needs to be put in place in a way that does not work only as a disincentive. It can be an incentive for people to invest in the solutions that are required.” 

However, environmentalists are sceptical about the effectiveness of carbon trading and taxation schemes, arguing that it is an easier way out for intensive-energy users who are increasingly under pressure to compensate for their greenhouse gas emissions. If the carbon tax is too low, there is little incentive for carbon-intensive industries to pay for costly tech to cut emissions, giving them licence to pollute. 

Lynn Forester de Rothschild, founding and managing partner of Inclusive Capital Partners, a San Francisco-based hedge fund manager, said that the divide is essentially between those who trust markets to adjust and “do the right thing” and those who do not.

Rothschild, a strong advocate for higher taxes on the wealthy and stricter regulation of big business, argued that despite the doubts, a price on carbon is needed for the market to have certainty.

According to estimates by the International Energy Agency, even as wind and solar projects continue to be rolled out at a startling pace, renewable energy will only make up 30 per cent of the world’s energy by 2024. Rothschild said that this is too slow.

“If we do not turbocharge the big solutions that can help the planet, then these technologies stay inside the oil and gas companies, because they will be the only ones who can do it. The price on carbon will be a lever for the development of technology and allow for solutions that are currently not commercially viable, such as carbon capture and the production of blue and green hydrogen, to be financed,” she said. 

“The problem is not a lack of innovation, but a lack of economics.” 

Rothschild noted that in the United States and United Kingdom, policymakers have backed the idea of a carbon dividend. Carbon dividends recycle the proceeds of a carbon tax back to households. This ensures that low-income households in particular are not worse off than before, or in some instances become net beneficiaries if they receive more money back than is taken by a carbon tax. 

The problem is not a lack of innovation, but a lack of economics.

Lynn Forester de Rothschild, founding and managing partner of Inclusive Capital Partners 

“It means that society will step in to take care of the people for whom the extra cost of taxation or carbon pricing, be it for electricity or transport, will be too much. Carbon dividends might be viewed as being too progressive now, but the idea behind them is definitely something that governments should consider, that we need to ensure that the burden of climate action would not be placed on the working class,” said Rothschild. 

Volatile transition ahead

Regulation around carbon taxation could play a role in making up the shortfall in sustainable investments. Pillay cautioned that not everyone is convinced that there is in fact a “climate dividend” which results in inaction and a reluctance to back sustainable investments.

“This is a big issue, because in the climate transition, the benefits come later and the costs are borne first. For an investor, you have to be prepared to put capital down for longer gestation periods. You have to take some zeroes in your portfolio,” he said. 

An acute energy squeeze in China and India this year signalled how volatile Asia’s energy transition is likely to be over the next few decades. “Governments need to be honest with the population about what the transition [will] mean for the people,” Pillay said, warning that there will be “disruptions to certain sectors and the workforce will need to adapt.”

In the climate transition, the benefits come later and the costs are borne first.

Dilhan Pillay Sandrasegara, chief executive of Temasek Holdings 

Hot on the heels of the COP26 climate conference, this year’s Bloomberg New Economy Forum placed a spotlight on the many climate commitments made in Glasgow.

On the issue of development finance, Ahmed M. Saeed, vice-president of the Asian Development Bank (ADB), said that getting too fixated on the US$100 billion pledge to help poor countries address climate change is focusing on the wrong problem. 

Instead, he thinks the problem is that the current sustainable finance taxonomy is not fit for purpose in emerging markets. “There are large crevices and money just sloshing around, not getting to achieve their purpose because of market structure mismatch. The issue in developing countries tends to be a lack of skills. Cost of capital is not the main issue,” said Saeed. 

Led by the US, developed countries pledged US$100 billion climate financing annually at COP15 in 2009 to help developing countries shift to a low-carbon future by 2020. A failure to meet this pledge has irked developing nations bearing the brunt of an acceleration away from fossil fuels, on which they largely depend, and the worst impacts of climate change which they charge is the fault of wealthier nations. 

Saeed said that the US$100 billion funding gap is a “made-up” number that is not grounded in fundamental analysis.

“It inherently assumes that what we are going through is a burden sharing exercise and that there is a cost to be shared, but we now know that almost every net-zero technology or activity will ultimately get to a point where it is commercially viable. There is a real need to change this narrative, otherwise people would not be motivated to seize opportunities,” he said, urging everyone to move past the current narrative. 

Saeed acknowledged that multilateral development banks and financial institutions have been called “laggards” when it comes to fixing climate finance. Scrutiny is likely to intensify in the second half of this decade and whether the financial industry can take global warming seriously will be the ultimate litmus test. 

“I am optimistic that development banks like ADB are uniquely positioned to act as intermediaries to support capital flows to developing countries, with our knowledge and networks built on the ground,” Saeed said. “It might be messy, but we are trying to get things done.” 

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